CBK

I sold the rest of my CBK position at around $2.60 about two weeks ago. And One risk for Flanagan’s Enterprises is that management expects higher seafood prices and since demand is elastic in this case, they can’t pass on the cost to the customers – this means lower future margins. I believe that risk is priced in at these levels when you take growth, the P/E, and also the excess equity of the land and buildings I mentioned earlier into account. I’m not a fan of investing in ‘growth’ stocks. Growth is usually a secondary reason for me and never the theme of a thesis. If it exists, that’s great, but I won’t buy something simply because it is growing. At a P/E of 10-11, the market is assuming it’s going to stay flat if seafood prices do not rise as fast as management expects, we could see some margin upside.

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I’m going to avoid the Euro Zone and allocate assets to North America (Canada and the USA). I believe all my subscribers live in North America anyways, so it’d better suit your portfolios.

The Euro Zone remains weak despite all the measures the ECB has taken to ‘revive’ it. And the Euro as a currency looks extremely suspect at this point. The Grexit episode is likely to repeat itself in a few years, maybe a Spain-exit and an Italy-exit as well? Pooling multiple non-correlative economies with independent debt loads under one currency was clearly a mistake. Negative interest rates are supposed to revive the euro-conomy, but hasn’t worked. I don’t know what is going on, but I want to minimize my exposure to the Euro Zone. 8/10 of Britain’s top trading partners are European countries. The other two are U.S. and China, with the U.S. being the largest and accounting for 14% of Britain’s exports.

There’s also the Brexit – Britain potentially exiting the European Union. The career politicians in the U.K. are spelling doom for the U.K. if they leave. If history does indeed rhyme, then Britain is probably more likely than not to benefit from leaving the European Union. These corrupt career politicians always seem to think they know what’s good for the countries, but usually get it wrong. People are starting to realize that creating the Euro was a mistake in the first place – the same politicians back in 2000 said it would be great for everyone, ‘facilitate efficient trade,’ ‘cut transaction costs’ – they forgot to mention the cons. It’s a good thing Britain avoided it.

This is something I’ve been debating for a while, and I’ve finally decided to cut ties with Europe. The portfolio will be approximately 25% Canadian stocks and 75% American stocks. I have just sold off Game Digital. Will be selling Tilly’s later this week. If Tilly’s drops to my break even point before I sell, I’ll immediately get rid of it. CBK will stay until I fill up 80% of the portfolio. I’m going to be coming up with a few more write-ups over the next few weeks. I’m hoping to have one more up by Thursday night.

Comparable sales down just 3.4% compared to the average double digit decline we saw in the earlier quarters

Gross Margin expansion

Inventories fell faster than sales once again

I believe what moved the stock was the Q1 guidance. CEO, LuAnn Via mentioned that comparable store sales so far have been positive for Q1. This is something I emphasized in my original thesis. Beating a -12% comp is not too difficult. What I was hoping for was for more inventory deleveraging than we saw. Although the inventory mix is much more favorable going into Q1 than it was last year, I was hoping to see some more deleveraging. Inventory numbers are still elevated, and at these prices, I’m going to take some chips off the table.

The average gain on CBK is 105% in just four months! I sold some earlier in February at $1.60, purchased more at $1.37 at the beginning of the month with the wave of buying I mentioned I was going to do in the February performance report. I sold 80% of my stake this morning at an average price of $2.62. It now makes up a minuscule 2.57% of the portfolio. Let’s hope for some momentum.

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Trimmed CBK yesterday by 25%, so it now makes up about 7.5% of the entire portfolio. Also added a new Canadian stock to the portfolio yesterday, Gamehost Inc. at CAD 8.16 (5% of the portfolio). I’m working on the write-up for it right now. I sold off magicJack at a 5% loss. It had a net effect of -0.5% to the entire portfolio, a very expensive mistake. The portfolio is nonetheless, still positive for the month February.

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Sales for the quarter were $103.6 million, compared to $110.6 million last year. Comparable store sales decreased 6.5%, gross margin came in at 35.8%, with a net loss of $0.01 per share. Inventories were down 11% QOQ, and 14% on a per sq ft. basis.

My Investment Thesis is playing out as I expected; the metrics are improving. Same-store sales were down 6.5% this quarter compared to 12.4% decline we saw in Q2. As more MPW stores enter the comp base, the metrics should improve even further. If the retail environment picks up, then the numbers should be even better.

Inventory metrics, IMO, are the highlight of Q3. Inventory turnover numbers had been abysmal leading up to this quarter. For Q3, however, Inventories are down 11% this quarter, more than the decline in sales of 6.3%. This compares to the inventory increase of 18% in 2014 Q3 while sales declined 6.4%. Management credited the improvement in inventory allocation and efficiency to the new business intelligence analytics software implemented earlier this year. This has enhanced the quality of the inventory mix going into Q4. Further conversions of CBK and CJ Banks stores should boost the inventory efficiency numbers as well and management plans to convert 20 CB and CJ stores into 10 MPW stores in Q4.

I was lucky enough to pick up more shares at $1.02 this morning at open after a brief ‘crash’ of 6%. The weighted average cost of my shares now is $1.17. CBK now makes up 6% of my portfolio. My price target remains the same at a market cap of $241 million or $6/share.

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I bought 3160 shares of Christopher & Banks at $1.27 for the virtual portfolio. It executed at $1.24 for my actual portfolio, but since the stock isn’t too liquid, I believe it drove the price up to $1.27. I was desperate for it to execute before leaving for work and decided to raise my limit price. It unfortunately now trades at $1.22 as we speak. My next trigger buy will be at $1.00.

Reason for the slump..

On September 3rd, CBK reported Q2 2014 results of 7.3% same store sales growth, as well as a 2.3% increase in sales. On October 7th, management updated their outlook for Q3. Management Reduced the gross margin improvement expectations, a reduction in SG&A expenses, Increase in inventory – due to softness in traffic trends. The stock has been beaten down to $1.24 (11/16/2015 close) from $9.37. To be fair, CBK reported the following for 2015 Q1:

During the first quarter, net sales per store decreased 7.9%, net sales per square foot decreased by 11.6%, gross margin per store decreased 13.3%, and gross margin per square foot decreased 16.8% as compared to the first quarter last year. (Source 10-Q)

and the following for 2015 Q2:

Net sales for the thirteen weeks ended August 1, 2015, were $94.0 million, a decrease of $12.6 million, 11.8%, from net sales of $106.6 million for the thirteen weeks ended August 2, 2014. The decrease in net sales was primarily a result of a 6.2% decrease in units purchased per transaction, operating an average of 24, or 4.4%, fewer stores …. Same-store sales decreased 12.4% for the thirteen weeks ended August 1, 2015, when compared to the thirteen weeks ended August 2, 2014; this follows a 4.7% same-store sales increase in last year’s second quarter. (Source: 10-Q)

It’s not as bad as it seems..

At first glance, those numbers look depressing. But after digging a little deeper, the patient investor will realize that the results are only so bad because of CBK’s new strategy. CBK has been in a strategic transition for about 5 years. Originally, CBK served the end customer through two brands; C.J. Banks and Christopher & Banks. C.J. Banks serves the plus-size market and Christopher & Banks serves the petite market. This strategy initially worked with gross margins peaking at 44% in FY’01 and then trending down for the following 11 years. They bottomed in FY’12 at 29.15%. Management decided to try a different strategy: Fusing both brands into one. This new single brand is known as Missy, Petite, Women or MPW. This strategy has increased store productivity, and enhanced operating efficiencies. We can see that in the data:

The number of stores is down from 775 to 518 or 33% but Sales/Sq-ft is up from 154 to 190 or 23%. Net sales are only down from 448 to 395 (TTM) or 13%, and given that one-third of the stores have been closed, that’s not too shabby.

Risks

Inventory numbers (TTM) – Inventory turnover is at the lowest it’s ever been, at 5.09, and days inventory is at its peak, at 71.67. Honestly, at these prices, inventory numbers are almost irrelevant. However, these numbers should be worked out as management finishes the transition to 100% MPW stores over the next 2 or so years. 66% of the operating leases expire over the next 3 years. Management is extremely aggressive with this transition.

Retail Slump – The retail slump generally does not last more than 2 years. The drop in Sales in one year only makes it easier for sales to “grow” the next year. Assuming it lasts 2 years, CBK has enough cash to weather the storm.

Run out of cash – As CBK opens new MPW stores, there is a risk that they will run dry. Cash flows were -$1.3m last year, and -$8.9m TTM. I believe management will handle this issue appropriately. Should management decide to raise cash, however, and the market punishes them for it, I will simply buy more.

Catalyst

Data

Same store sales calculation for Q1 & Q2 excludes 50% and 46% of the stores. The stores that were excluded are all MPW stores, since they are the only ones tha have been remodeled. The MPW stores have higher gross and operating margins than the C.J. Banks and the Christopher & Banks stores. FY’15 ends on January 31st. FY’16 should polish these numbers as the MPW stores will be now be counted, and the Christopher & Banks as well as C.J. Banks will slowly become trivial. This will drive up same store sales numbers, the stock price should follow.

Our same-store sales data is calculated based on the change in net sales for stores that have been open for more than 13 full months and includes stores, if any, that have been relocated within the same mall. Stores where square footage has been changed by more than 25 percent are excluded from the same-store sales calculation for 13 full months following the change. Stores closed during the fiscal year are included in the same-store sales calculation only for the full months of the fiscal year the stores were open. (Source: 10-Q)

29% of stores have not been consolidated

As of August 1, 2015, CBK operated 529 stores: 82 Christopher & Banks, 73 C.J. Banks, 309 Missy, Petite, Women, and 65 outlet stores. Management plans to close some of the 155 Christopher & Banks and C.J. Banks, and convert the rest to MPW. As this process goes through, the other Net sales comparable metrics should trend higher, the stock price should follow.

Valuation

The retail industry is in a slump, and retail stocks have been punished over the past few months. The genuine gross and operating margins are being masked by the C.J. Banks and Christopher & Banks stores, as well as the retail slump. Management says that their long-term goal is to increase gross margins by an additional 250 to 350 bps from 35.31% over the long-term. I believe they have the potential to go even higher than 37.8% or 38.8%. The MPW stores are just so much more efficient. But we will use management’s assumptions for valuation purposes.

The Market Cap as of today, 11/16/2015 is 46.2 million. CBK carries 34.5 million cash, has no debt. Enterprise value is $11.72 million. EBIT for FY’14 (before the retail slump) was $9 million for an EV/EBIT ratio of 1.3.

I don’t have access to real-time industry data, but Macy’s and Kohl’s trade for around 7x EBIT right now. So, assuming a reasonable multiple of 6x EBIT, we arrive at a value of value of 54 million + 34.5 million (cash) = 88.5 for a 91% upside.

Assuming gross margins thread higher to 38.2% (mean of what management expects, but still lower than historical gross margins), we will end up with an Operating income/EBIT of $33.51 million. 6x EBIT = $207 million, add the cash balance of $34.5, and we arrive at $241 million for a 521% upside.

The above are conservative cases.

For a more aggressive case: S&P EV/EBITDA is 12x. If we use EBITDA and not EBIT, add depreciation of $11.5 to $33.5 million EBIT, we arrive at $45 million EBITDA, a value that approximates today’s market cap of $46 million. Now tag on the 12x, and we arrive at $540 million for a Peter Lynch like 10 bagger ~ 1174% upside.

Time Frame: 6 – 24 months

The operating margins should normalize over the next few years as retail recovers and management works down excess inventory. The patient investor will be rewarded handsomely. My favorite type of valuation is the one that does not require a spreadsheet. I’m buying 3200 shares at market open.